New model predicts default probabilities using credit spread options.
The article explores how credit spreads and credit spread options can be modeled using a two-factor framework. By analyzing the stochastic evolution of credit spreads, researchers were able to estimate credit spread curves and imply default probabilities. This approach allows for fitting complex credit curves and calibrating credit spread options prices using a replicating strategy. The study found that the estimated credit spread curves can be used to determine default probabilities under specific credit risk models.